Disparate Impact in Fair Lending: a Theory Without a Basis & the Law Of

ELECTRONICALLY REPRINTED FROM FEBRUARY 2014 Disparate Impact in Fair Lending: A Theory without a Basis & the Law of Unintended Consequences

By Andrew L. Sandler and Kirk D. Jensen

he disparate impact theory of discrimination allows agencies and/or community organizations receiving govern- T the government or a private plaintiff to establish dis- ment funding, both cases settled shortly before oral argument, crimination based solely on the outcome of a neutral policy, denying the Supreme Court the opportunity to rule on the without having to prove any actual intent to discriminate. longstanding issue. Although the text of the Fair Housing Act (FHA) does not create liability for facially neutral activities with unequal The Theory effects, lower court decisions over the years have relied on The disparate impact theory of discrimination allows jurisprudence focused on other statutes with different lan- a party to establish discrimination based solely on the guage, agency guidance, and selective readings of legislative results of a neutral policy. Disparate impact is distinct history to permit disparate impact claims. The US Supreme from disparate treatment because a party is not required to Court more recently has issued several decisions undermining show any intent to discriminate. To establish a disparate this broad focus on the goals of the FHA, holding that the impact claim, a government agency or private plaintiff plain language of an anti-discrimination statute—and not a must show only that an otherwise neutral practice dispa- broad interpretation of its purpose—is dispositive of whether rately affects qualified members of a protected class. disparate impact claims are permitted. Nonetheless, these Supreme Court cases have not addressed the use of disparate Application of Doctrine in FHA Actions impact under the FHA directly, and federal regulatory and The notion that the Fair Housing Act (FHA) per- enforcement agencies with fair lending enforcement authority mits disparate impact claims originated in three lower seeking to achieve broad policy objectives increasingly seek court decisions in the 1970s—United States v. City of to rely on disparate impact claims to advance their agenda. Black Jack,1 Metropolitan Housing Development Corp. v. Because lenders have been reluctant to engage in protracted Village of Arlington Heights (Arlington Heights II ),2 and litigation with these agencies, disparate impact analysis con- Resident Advisory Board v. Rizzo.3 None of these cases tinues to be effectively used to place affirmative obligations held that the statutory text of the FHA permitted on lenders with respect to the underwriting and pricing of disparate impact claims—indeed, one of these cases, loans to protected-class borrowers designed to achieve statisti- Arlington Heights II, acknowledged that the text of the cal equivalence between groups. In effect, this result chills FHA requires a showing of intent to discriminate to innovation and reduces the breadth of credit available to establish claims of discrimination.4 Rather, these courts qualified borrowers, causing lenders to retreat from offering focused on cases decided under other laws and what the lending products and services that could increase vulnerability courts viewed as the broad purpose of the FHA. Lower to claims of discrimination based only on statistical outcomes courts subsequently followed these original three of objective and neutrally applied lending criteria. The FHA disparate impact decisions and incorporated the Supreme Court signaled its interest in addressing directly rationale set forth in those opinions. However, recent the threshold question of whether the FHA permits dispa- Supreme Court precedent focused on other discrimi- rate impact claims last term and again this term, granting nation statutes now has undermined this approach.5 certiorari on the issue in two successive cases. However, with Nonetheless, in the absence of a Supreme Court deci- the active encouragement and participation of government sion directly addressing the appropriate discrimination standard under the FHA, government agencies and the Andrew L. Sandler is Chairman and Executive Partner of occasional lower court continue to permit use of dis- BuckleySandler LLP and Kirk D. Jensen is a partner in the firm’s parate impact analysis to advance discrimination claims Washington D.C. office. in the lending context.

1 • Banking & Financial Services Policy Report Volume 33 • Number 2 • February 2014 Interagency Adoption of Standard burden-shifting approach to establishing liability under and Subsequent Enforcement this theory.10 The rule was finalized in 2013, just weeks Government agencies with fair lending enforcement after the Supreme Court agreed to hear a second case powers issued a broad interagency Policy Statement raising the question of whether the FHA permits dis- on Discrimination in Lending in 1994. The Policy parate impact claims.11 The final rule (HUD Rule) Statement addressed many aspects of the government’s ostensibly authorizes private and governmental plain- fair lending expectations of banks and other entities tiffs to assert discrimination under the FHA based on engaged in lending activity. Among the guidance mortgage-lending practices that have a disparate impact provided was a statement that liability for violations on a protected class of individuals or that otherwise of both the FHA and the Equal Credit Opportunity create, increase, reinforce, or perpetuate segregated Act (ECOA) could be based on evidence of disparate housing patterns, even if the practice is facially neutral impact.6 At the same time, the Federal Reserve Board and there is no evidence of discriminatory motivation.12 (FRB) amended its commentary to Regulation B Subsequent to HUD issuing its proposed rule on dispa- implementing ECOA to note that use of the disparate rate impact, the Consumer Financial Protection Bureau impact theory is appropriate.7 However, these state- (CFPB) also took the position, relying on Regulation B, ments were made in the context of a broad Policy that ECOA permits disparate impact claims.13 The DOJ Statement, which expressly recognized that factors such has similarly reaffirmed its position that both the FHA as borrower’s income, continuity of income, adequacy and ECOA permit disparate impact claims.14 of collateral, and availability of funds to close—­ objective considerations that often “effect” the decision Recent Supreme Court Jurisprudence on whether to make and how to price a loan—remain Establishing Primacy of the Statutory Text relevant to credit decisions.8 Given the continued This relatively new reliance by the DOJ and other commitment to the notion that these objective factors government agencies on the disparate impact theory appropriately might “effect” the lending decision, gov- analysis is directly inconsistent with recent Supreme ernmental fair lending enforcement activity from 1994 Court jurisprudence setting forth the appropriate lim- until 2008 continued to be focused almost exclusively its in use of the disparate impact theory. In 2005, the on cases in which disparate treatment could be proven. Supreme Court clarified its position with respect to During this period no government fair lending cases congressional antidiscrimination statutes, explaining were brought based exclusively on statistical analysis that the text of an antidiscrimination statute is disposi- showing nonequivalent results in availability or pricing tive of whether disparate impact is available.15 of credit without regard to borrower loan qualifications or risk. In Smith v. City of Jackson,16 the Court clarified that its decisions permitting disparate impact claims in employ- This approach to fair lending enforcement changed ment cases were based on specific language in Title VII in 2009 when the Department of Justice Civil Rights and not broad interpretations of the statute’s general Division (DOJ) announced that it would now pur- purpose. The Court explained that Title VII contains sue fair lending cases based on statistical evidence two different provisions that prohibit discrimination: that neutral lending practices were having dispropor- One that requires a showing of intent to discriminate, tional effects on members of protected classes. The and a second which provides that an employer may not Department of Housing and Urban Development take actions that negatively “affect” a person’s employ- (HUD)—the executive agency charged with adminis- ment on the basis of race, sex, and other attributes. tering, interpreting, and enforcing the FHA—soon fol- The City of Jackson Court explained that this “effects” lowed with similar pronouncements. Since that time, language permits disparate impact claims and does not the DOJ and HUD have brought numerous cases based require a showing of intent. However, a close reading on that theory.9 of the FHA and ECOA reveals that both statutes have only the language that the Supreme Court explained Most recently, HUD issued a proposed regulation requires claimants to prove intent to discriminate—and purporting to authorize discrimination claims based on neither statute has the “effects” language that the Court disparate impact under the FHA and codify a three-step, explained permits disparate impact claims.

Volume 33 • Number 2 • February 2014 Banking & Financial Services Policy Report • 2 The ‘Effects’ Test his status as an employee, because of such individual’s” The question before the Supreme Court in City race or age.22 The phrase “otherwise adversely affect” of Jackson was whether the Age Discrimination in was critical to the plurality opinion’s conclusion. Employment Act (ADEA) permits disparate impact Although Justice Stevens acknowledged that the Griggs claims. To resolve this question, the Court first exam- Court had also relied on the purposes of Title VII, ined its prior interpretations of parallel antidiscrimina- the Court had “subsequently noted that [the Court’s] tion provisions in Title VII. The Court focused on holding [in Griggs] represented the better reading of the Griggs v. Duke Power Co., in which it originally held statutory text.”23 that Title VII permits disparate impact claims. In exam- ining its Title VII jurisprudence, the Court clarified The Court further clarified in City of Jackson that that the text of an antidiscrimination statute, not merely Section 703(a)(1) requires a showing of intent to dis- a broad interpretation of the statute’s purpose, resolves criminate and “does not encompass disparate-impact whether the statute permits disparate impact claims. liability.”24 Similarly, Justice O’Connor, with whom Justices Kennedy and Thomas joined in dissent, Essential to understanding City of Jackson and Griggs thought it “obvious” that Section 703(a)(1) does not is to realize that Title VII contains two distinct provi- authorize disparate impact claims, but rather “plainly sions prohibiting different discriminatory employment requires discriminatory intent.”25 The “discriminate practices. These two provisions, contained in Section against … because of” language is the key text in 703 of Title VII, state: Section 703(a)(1) supporting a requirement of dis- criminatory intent. Critically, Section 703(a)(1) does 1. It shall be an unlawful employment practice for an not contain the “effects” language present in Section employer – 703(a)(2). 1. to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against any individual After clarifying its Title VII jurisprudence, the Court with respect to his compensation, terms, conditions, held that the ADEA also permits disparate impact claims or privileges of employment, because of such indi- because it contains a parallel provision to the disparate vidual’s race, color, religion, sex, or national origin; or impact provision of Title VII (Section 703(a)(2)). This 2. to limit, segregate, or classify his employees or holding is consistent with other Supreme Court opin- applicants for employment in any way which ions holding that various statutes that contain “effects” would deprive or tend to deprive any individual or “results” language permit disparate impact claims.26 of employment opportunities or otherwise adversely The Court has held that the Americans with Disabilities affect his status as an employee, because of such indi- Act (ADA), which prohibits “utilizing standards, crite- vidual’s race, color, religion, sex, or national origin.17 ria, or methods of administration … that have the effect of discrimination,” permits disparate impact claims. Justice Stevens’ plurality opinion in City of Jackson The Court reached the same conclusion with respect clarified that the Court’s holding in Griggs that Title to the Rehabilitation Act, which incorporates by refer- VII permits disparate impact claims was based on the ence the standards applicable under the ADA,27 and “effects” language in Section 703(a)(2).18 Indeed, the the Voting Rights Act,28 which prohibits any voting opinion in Griggs quoted only Section 703(a)(2).19 prerequisites or standards “result[ing] in a denial” of Section 703(a)(2), explained Justice Stevens, “focuses the right to vote “on account of race or color.”29 In on the effects of the action on the employee rather than contrast, the Court has consistently held that statutes the motivation for the action of the employer.”20 Put lacking “effects” or “results” language do not create a differently, “Congress had ‘directed the thrust of the disparate impact cause of action.30 Act [Title VII] to the consequences of employment prac- tices, not simply the motivations.’”21 Justice Stevens City of Jackson is but one in a continuing line of reasoned that Section 703(a)(2) not only “prohibits Supreme Court cases that reminded courts and litigants actions that ‘limit, segregate, or classify’ persons,” but to look to the text of the statute when determining also “prohibits such actions that ‘deprive any individual whether a particular cause of action exists.31 The most of employment opportunities or otherwise adversely affect recent reminder of this tenet came in May 2012, when

3 • Banking & Financial Services Policy Report Volume 33 • Number 2 • February 2014 the Supreme Court reiterated that “[v]ague notions of The obvious similarities and glaring differences statutory purpose provide no warrant for expanding between the text of the FHA and ECOA and the [a statute’s] prohibition beyond the field to which it is text of Title VII and the ADEA are dispositive of unambiguously limited[.]”32 Congress’s intent in enacting these statutes. The simi- larities and differences are even more significant con- Application to Text of FHA and ECOA sidering that Congress enacted Title VII (1964), the As demonstrated in the following chart, the FHA ADEA (1967), the FHA (1968), and ECOA (1974) in and ECOA contain similar language to the disparate quick succession. The Supreme Court has explained treatment provisions of Title VII and the ADEA— that “when Congress uses the same language in two which the Supreme Court has clarified require a show- statutes having similar purposes, particularly when one ing of intent to discriminate. However, neither statute is enacted shortly after the other, it is appropriate to contains any language resembling the disparate impact presume that Congress intended that text to have the provisions of those statutes. same meaning in both statutes.”33 The converse is also

Disparate Treatment Language: Disparate Impact Language: Title VII (a) It shall be an unlawful employment practice for (a) It shall be an unlawful employment practice for an employer (1) to fail or refuse to hire or to dis- an employer … (2) to limit, segregate, or classify his charge any individual, or otherwise to discriminate employees or applicants for employment in any way against any individual with respect to his compensa- which would deprive or tend to deprive any individ- tion, terms, conditions, or privileges of employment, ual of employment opportunities or otherwise adversely because of such individual’s race, color, religion, sex, or affect his status as an employee, because of such indi- national origin; … vidual’s race, color, religion, sex, or national origin.

ADEA (a) It shall be unlawful for an employer: (1) to fail (a) It shall be unlawful for an employer: … (2) to limit, or refuse to hire or to discharge any individual or segregate, or classify his employees in any way which otherwise discriminate against any individual with would deprive or tend to deprive any individual of respect to his compensation, terms, conditions, or employment opportunities or otherwise adversely privileges of employment, because of such individu- affect his status as an employee, because of such indi- al’s age; … vidual’s age[.]

FHA (a) In general. It shall be unlawful for any person or None. other entity whose business includes engaging in residential real estate-related transactions to discriminate against any person in making available such a transac- tion, or in the terms or conditions of such a trans- action, because of race, color, religion, sex, handicap, familial status, or national origin.

ECOA (a) It shall be unlawful for any creditor to discriminate None. against any applicant, with respect to any aspect of a credit transaction—(1) on the basis of race, color, reli- gion, national origin, sex or marital status, or age … ;

Volume 33 • Number 2 • February 2014 Banking & Financial Services Policy Report • 4 true. Then-Judge John Roberts explained that “[t]his Lower court decisions concluding that ECOA per- use of different language in two statutes so analogous mits disparate impact claims similarly rest on a shaky in their form and content, enacted so closely in time, foundation that has crumbled in light of City of Jackson. suggests that the statutes differ in their meaning.”34 Instead of analyzing the language of ECOA, courts have relied on nonstatutory references to disparate The ordinary meaning of the term “discriminate” impact under ECOA.40 At the root of these non- further supports the position that the “discriminate …. statutory references are two congressional committee because of” and “discriminate … on the basis of” lan- reports related to a subsequent amendment to ECOA guage in the FHA and ECOA requires a showing of that did not alter the “discriminate against … on the intent. When terms are not defined in a statute, those basis of” language in ECOA.41 The 1976 amendments terms are given their ordinary meaning.35 The ordinary to ECOA expanded the prohibited bases of ECOA to meaning of “discriminate” refers to the intentional treat- include race, age, and other attributes, but did not add ment of one person differently than another.36 Engaging “effects” language to ECOA or otherwise change the in a certain practice that has a disparate impact without basic “discriminate against … on the basis of” structure discriminatory intent is not “discrimination” in the ordi- of the statute.42 nary sense of the word, and yet courts and government agencies have nonetheless permitted disparate impact Reliance on contemporary legislative history is gen- under the FHA and ECOA. In fact, the plaintiff’s bar has erally not appropriate when the language of the under- argued that disparate impact liability can be found even lying statute is clear. It is never appropriate when, as for actions intended to prevent discrimination if those here, the purportedly relevant congressional committee actions have a disparate impact.37 Congress’s decision reports are from a subsequent Congress that did not even to use the term “discriminate” in the FHA and ECOA amend the relevant text of the statute. The Supreme without any “effects” language signifies a deliberate deci- Court has specifically noted that inferring the intent of sion to require a showing of intent to discriminate—not an earlier Congress from the legislative history of a later to permit disparate impact claims under the FHA and Congress is “hazardous.”43 Indeed, such uses of legisla- ECOA. tive history has been criticized as lending itself “to a kind of ventriloquism,” which can be employed “to Misinterpretation of Supreme Court make words appear to come from Congress’s mouth Precedent by Lower Courts which were spoken or written by others (individual No lower court has held that the text of either the Members of Congress, congressional aides, or even FHA or ECOA permits disparate impact claims in enterprising lobbyists).”44 Committee reports from a the fair lending context. Nonetheless, several federal subsequent Congress ought to have no place in deter- district courts have continued to rely on nonstatu- mining Congress’s intent in enacting ECOA. tory references—and appellate court opinions relying on nonstatutory references—to uphold use of the Appellate Treatment Post-City of Jackson theory,38 contrary to Supreme Court precedent. These Although 11 of the 12 federal courts of appeal held district court decisions cannot be squared with the prior to City of Jackson that the FHA and ECOA permit Supreme Court’s holding in City of Jackson and other disparate impact claims,45 decisions since 2005 have cases. The language of the FHA is plain; accordingly, relied solely on pre-City of Jackson precedent that has the analysis of the FHA must begin and end with the since been discredited, without analyzing or otherwise statutory text.39 Resort to legislative history is unnec- acknowledging the Supreme Court’s City of Jackson essary and unwarranted. Indeed, no federal court of opinion.46 Further, the US Court of Appeals for the appeals has addressed the issue since City of Jackson, District of Columbia Circuit has signaled that ECOA and two have questioned whether use of the disparate does not permit disparate impact claims,47 and five impact theory in such cases remains appropriate, sig- judges from the US Court of Appeals for the Eighth naling an opportunity to return fair lending enforce- Circuit have argued that the issue of disparate impact ment to the prohibition of intentional discrimination under the FHA “is appropriate for careful review.”48 for an impermissible purpose contained in the statu- In Garcia v. Johanns, the DC Circuit observed that tory text. “[t]he Supreme Court has held that this [‘effects’]

5 • Banking & Financial Services Policy Report Volume 33 • Number 2 • February 2014 language gives rise to a cause of action for disparate In June 2013, the Supreme Court granted certiorari in impact discrimination under Title VII and the ADEA,” Mount Holly. Though not a lending case, the Mount Holly citing to City of Jackson, but noting that “ECOA con- appeal would have allowed the Supreme Court to rule on tains no such language.”49 In Magner v. Gallagher, five the same threshold question presented in Magner—that is, judges dissented from a denial of en banc rehearing, whether disparate impact claims are cognizable under the noting that “recent developments in the law,” primar- FHA. As in Magner, the New Jersey Township of Mount ily City of Jackson, “suggest that the issue [of disparate Holly withdrew its petition prior to oral argument after impact under the FHA] is appropriate for careful the Township settled its dispute.57 review by the en banc court.”50 The Supreme Court may have yet another chance Supreme Court Attempts to address this issue in an action filed by two home- to Rule on Validity of Doctrine owners’ insurance associations earlier this year, which The Supreme Court nearly had the opportunity had been stayed in federal district court in D.C. pend- to address the threshold question of whether dispa- ing the outcome of the Mount Holly appeal.58 The rate impact claims are permitted under the FHA in lawsuit challenges the validity of the HUD Rule, Magner v. Gallagher and again in Township of Mount alleging that it violates the Administrative Procedures Holly, New Jersey, et al. v. Mt. Holly Gardens Citizens in Act by contradicting the plain language of the FHA. Action, Inc., et al. However, in both cases, the petition- The associations argue that the HUD Rule, if applied ers withdrew their respective appeals shortly before the to homeowners’ insurance, would require insurers Court was scheduled to hear arguments, preventing the “to consider characteristics such as race and ethnic- Supreme Court from deciding this longstanding issue. ity and to disregard legitimate risk-related factors,” Luckily, a third case that raises issues substantially simi- thereby forcing insurers “to provide and price insur- lar to those presented in Magner and Mount Holly may ance in a manner that is wholly inconsistent with be headed to the Supreme Court. well-­established principles of actuarial practice and applicable state insurance law.” The City of St. Paul, Minnesota—the Petitioner in Magner—filed a petition for certiorari that was granted In light of the Supreme Court’s decision to hear the by the Supreme Court last term,51 after its petition for Magner and Mount Holly appeals—and the efforts by rehearing before the Eight Circuit en banc was denied.52 DOJ and other supporters of the broad use of disparate Although the district court ruled for the City,53 the impact theory to avoid Supreme Court scrutiny of its Eighth Circuit reversed, holding that the respondents application in fair lending matters—there is hope that had stated a cognizable claim under the FHA.54 After courts will be more willing to carefully review City of briefing, but before argument, the Supreme Court Jackson and its impact on the validity of prior decisions dismissed the case at the City of St. Paul’s request. under the FHA and ECOA. However, there seems to be a general consensus that the Supreme Court would have sided with the City of Invalidity of Agency Attempts St. Paul and held that the FHA does not permit disparate to Establish Disparate Impact Standard impact claims, in no small part because the Court took Despite Supreme Court precedent calling into ques- the case notwithstanding the lack of a circuit split on the tion the appropriateness of disparate impact claims in the issue. Indeed, the Mayor of the City of St. Paul stated fair lending context—and despite the Supreme Court as much in explaining the City’s decision to withdraw agreeing twice in as many terms to consider whether its appeal, noting that the City was confident it would the FHA permits disparate impact claims—government win.55 The City’s stated reason for withdrawing its case agencies continue to assert the theory in policy state- was concern that its victory in the Supreme Court could ments, enforcement actions, and supervisory examina- set back civil rights enforcement by eliminating the tions. However, as discussed previously, neither the future use of the disparate impact theory. Civil rights FHA nor ECOA contain the statutory language that advocates and government officials were similarly so permits disparate impact claims. Accordingly, these concerned that they undertook great efforts to persuade efforts to support disparate impact are contrary to con- the City of St. Paul to withdraw its appeal.56 trolling law.

Volume 33 • Number 2 • February 2014 Banking & Financial Services Policy Report • 6 Lack of Support or Authority for Actions are entitled to deference only when there is an ambi- A close review of the positions asserted by HUD, guity in the statute and only if the agency’s interpreta- DOJ, the FRB, and the CFPB shows that each is based tion is reasonable.70 The Freeman Court unanimously on a now-discredited interpretation of law. HUD reminded HUD, however, that its interpretations are bases its position on the holdings by federal courts of not entitled to deference when its interpretation “goes appeals that the FHA permits disparate impact claims.59 beyond the meaning that the statute can bear.”71 The Similarly, DOJ—in the interagency Policy Statement Court has previously explained that “ ‘regulations that on Discrimination in Lending—bases its position on would proscribe conduct by the recipient having only a the holdings by federal courts of appeal prior to City discriminatory effect … do not simply “further” the pur- of Jackson,60 despite the fact that City of Jackson now pose of [the statute]; they go well beyond that purpose’ ” shows that these lower court decisions are incorrect and are not entitled to deference.72 This analysis would and inconsistent with the language of the statute. be equally applicable to any final HUD rule. When a In addition to basing its view on pre-City of Jackson statute like the FHA does not permit disparate impact cases,61 the FRB also relied on the preenactment leg- claims, such claims cannot be authorized by regulation. islative history of ECOA in addressing the effects test Freeman suggests that HUD should exercise caution in Regulation B.62 The CFPB, which now has author- before attempting to promulgate a rule inconsistent ity over Regulation B, followed suit.63 As discussed with the underlying statute. previously, however, this legislative history post-dates the enactment of ECOA and cannot change the plain Unintended Consequences meaning of the statutory text. The FRB also relied on of Continued Application the Civil Rights Act of 1991, which amended Title VII The Supreme Court’s repeated decision to rule on but did not amend any other civil rights law.64 But the the validity of the disparate impact doctrine in the Supreme Court has since clarified that the 1991 legisla- FHA context reflects the serious public policy con- tion only amended Title VII—and does not affect the cerns raised by continued application of the theory in interpretation of any other civil rights law.65 certain housing contexts, particularly from a lending perspective. Relying on disparate impact to establish Furthermore, a regulatory agency is not authorized discrimination in lending poses a real threat to market to attempt to effectuate an interpretation of a statute expansion and economic stability. Further, continued by prohibiting conduct the statute permits. As Justice application of the theory could actually facilitate and O’Connor has explained: “an agency’s legislative regu- institutionalize discriminatory practices and abate con- lations will be upheld if they are ‘reasonably related’ sumer protection efforts. to the purposes of the enabling statute, … [W]e would expand considerably the discretion and power of agen- Stifled Marketplace cies were we to interpret ‘reasonably related’ to permit The mortgage-lending market is sustained and agencies to proscribe conduct Congress did not intend advanced through innovation and growth. Exposing to prohibit.”66 “ ‘[R]egulations that would proscribe lenders to potential liability for lending activities based conduct by the recipient having only a discriminatory only on superficial statistical analysis showing differential effect … do not simply “further” the purpose of the [stat- impact on a particular group without meaningful controls ute]; they go well beyond that purpose.’ ”67 for objective lending qualifications hinders lenders’ ability to create new products and extend business operations, Recent Precedent Limiting Agency thereby stifling market expansion. Nontraditional mort- Rulemaking gage products have afforded access to mortgage financing Recent Supreme Court precedent further signals to a wide spectrum of consumers that do not desire or that the HUD Rule adopting disparate impact under otherwise qualify for a traditional mortgage. However, the FHA cannot stand. In Freeman v. Quicken Loans,68 even if policies associated with such products are applied the Supreme Court unanimously rejected a HUD neutrally to all consumers, a lender may be forced to interpretation of the Real Estate Settlement Procedures stop offering the product in order to equalize the effects Act that the Court found to be “manifestly inconsistent of their lending activities on minority and nonminority with the statute.”69 Agency interpretations of statutes borrowers. For example, certain loan products may be

7 • Banking & Financial Services Policy Report Volume 33 • Number 2 • February 2014 optimal for a limited subset of borrowers. If minorities the latter option. If that choice is made, the likelihood are not proportionately represented in that subset of bor- of loan defaults with negative implications for borrowers rowers, offering the products—even on a demonstrably and neighborhoods increase. fair and nondiscriminatory basis to all qualified borrow- ers—could increase the lender’s exposure to liability, Consumer Protection Risks despite the complete absence of discriminatory intent or Discretionary pricing, when used appropriately, pro- conduct, solely because proportionately more nonminor- tects mortgage lenders and borrowers alike. A traditional ity borrowers qualify for the product. Faced with the mortgage is not a realistic option for a large segment possibility of accusations of discriminatory lending, many of consumers. Through market innovation, nontradi- lenders will choose not to offer such products, thereby tional mortgage products were created that afford high- depriving qualified borrowers, minority and nonminority risk consumers the opportunity to obtain home loans. alike, of good credit alternatives. However, as discussed previously, continued use of the disparate impact theory could make lenders reluctant to An outcome-driven approach to assessing discrimina- offer mortgage products tailored to a particular type of tion likewise creates unreasonable risk for lenders that borrower or set of circumstances, which by their nature might otherwise seek to expand into new markets. For invite differential application and thereby a potential dis- example, lending opportunities might be more limited proportionate effect. The impact of such a market change in census tracts with greater minority populations, like would be felt most substantially by high-risk consumers urban areas, which increases lender exposure to accusa- who rely on nontraditional products for access to credit. tions of redlining discrimination. A lender otherwise If fear of liability discourages lenders from creating and interested in growing its lending operations in an urban offering products suitable for such borrowers, a large seg- area with pronounced credit needs may thus choose not ment of consumers could be effectively denied access to to do so because of the significant risk, effectively depriv- responsible loan products. If this occurs, other less repu- ing all potential borrowers in the community of the ben- table lenders will step in and fill the vacuum with loan efits of an additional loan source. products bearing far more problematic terms and costs. Thus, well-intentioned but misguided efforts to prevent Economic Instability discrimination may in effect increase minority borrowers’ Application of the disparate impact theory in fair exposure to predatory lending practices. lending matters also threatens to undermine traditional underwriting practices. The approach employed to Facilitate Discriminatory Practices determine whether discretionary loan pricing resulted Lastly, focus on equal ends rather than equal oppor- in discriminatory impact focuses only on statistical out- tunity may actually facilitate discrimination by ren- comes, without regard to the factors most reliable in dering quotas and preferential treatment as the only predicting default, such as credit scores, loan-to-value cost-effective means for limiting exposure to disparate ratios, and debt-to-income ratios. Reducing emphasis impact liability. The Supreme Court has acknowledged on those factors may lead lenders to place less emphasis that “[i]f quotas and preferential treatment become the on traditional underwriting criteria in an effort to equally only cost-effective means of avoiding expensive litiga- apportion mortgages among all groups of borrowers and tion and potentially catastrophic liability, such measures avoid accusations of discrimination, notwithstanding that will be widely adopted.”73 Further, the Supreme Court each group may not have precisely equal credit qualifica- cautioned in the Title VII context that regulations which, tions. For example, if a minority group is statistically less as applied, give employers “little choice” but to adopt likely to qualify for a mortgage product or particular loan race-conscious measures can violate the Constitution.74 terms under a neutral policy, the lender would be forced to either stand by the policy and risk being accused of Conclusion discrimination under a disparate impact statistical analysis Congress appropriately designed the FHA and or ease its underwriting standards to achieve equivalent ECOA to prohibit only intentional discrimina- market share among minority and nonminority borrow- tion, which the text of both statutes makes clear. ers. The substantial financial and reputational costs asso- Arguments for incorporating the disparate impact ciated with discrimination allegations could incentivize theory into either statute are squarely inconsistent

Volume 33 • Number 2 • February 2014 Banking & Financial Services Policy Report • 8 with the statutory texts and cannot be reconciled 6. Policy Statement on Discrimination in Lending, April 15, 1994. with the Supreme Court’s precedent in City of Jackson Federal Reserve Regulatory Service, Page 6-58.1. and its progeny. Rule[makings, bulletins, and other 7. 12 C.F.R. Part 202, Commentary 202.6 at 6(a)-2 (recodified at agency guidance cannot prohibit what Congress has 12 C.F.R. Part 1002). not, and such actions ultimately will not survive judi- 8. Policy Statement on Discrimination in Lending, April 15, 1994. cial scrutiny. Federal Reserve Regulatory Service, Page 6-58.6. 9. For example, Luther Burbank increased its 1–4 family resi- There is no question that inadequate access to credit dential mortgage lending by acquiring a jumbo single-family in certain communities in the urban core is a real con- loan unit specializing in adjustable-rate mortgages (ARMs) and nontraditional mortgages (NTMs) that had been operat- cern that needs to be addressed. However, recent years ing an identical program at another thrift for 10 years. The have seen a trend of discrimination allegations that decision to expand into this niche market instead of offering are not justified and raise serious concerns for market 30-year fixed products was driven by safety and soundness sustainability and consumer protection. To effectively concerns. Although the Bank was willing to expand its 1–4 address this problem, regulatory and judicial focus must family residential mortgage business, the Bank’s legitimate concerns about the appropriateness of offering these products be on whether consumers are treated fairly in the lend- to unsophisticated borrowers through third-party brokers led ing process, rather than on accusing lenders of discrimi- the Bank to limit the availability of these products through the nation for not affirmatively bringing credit into such wholesale channel to borrowers seeking loans of $400,000 or areas. Beware the law of unintended consequences. more. Despite the valid, nondiscriminatory reasons supporting the Bank’s neutral minimum loan policy, the DOJ pursued a Notes multimillion dollar action against the Bank based on an alleged 1. 508 F.2d 1179 (8th Cir. 1974). disparate impact on African-American and Hispanic potential borrowers. 2. 558 F.2d 1283 (7th Cir. 1977). 10. Implementation of the Fair Housing Act’s Discriminatory 3. 564 F.2d 126 (3d Cir. 1977). Effects Standard, 76 Fed. Reg. 70921 (proposed Nov. 16, 2011). 4. Arlington Heights II, 558 F.2d at 1288 (acknowledging that a 11. Implementation of the Fair Housing Act’s Discriminatory “narrow view of the phrase [‘because of race’]” in the statute Effects Standard, 78 Fed. Reg. 11,460 (Feb. 15, 2013) (codi- would require intent to discriminate). fied at 24 C.F.R. 100). See also Wards Cove Packing Co., Inc. v. 5. The Black Jack court relied exclusively on constitutional equal Antonio, 490 US 642 (1989). The Supreme Court has clarified protection cases to support its conclusion that the FHA per- that Wards Cove continues to apply to civil rights laws other mits disparate impact claims. Black Jack, 508 F.2d at 1185. Soon than Title VII. Smith v. City of Jackson, 544 U.S. 228, 240 (2005) after, the Supreme Court effectively undermined Black Jack (“While the relevant 1991 amendments expanded the cover- when it overruled the equal protection cases the Black Jack age of Title VII, they did not amend the ADEA or speak to court had relied upon and held that equal protection violations the subject of age discrimination. Hence, Wards Cove ’s pre- require a showing of discriminatory intent. Washington v. Davis, 1991 interpretation of Title VII’s identical language remains 426 US 229, 238–39, 244 n.12 (1976). The Arlington Heights applicable to the ADEA.”). Similarly, because the Civil Rights II court concluded that the FHA permitted disparate impact Act of 1991 did not amend the FHA or ECOA, the Wards claims in spite of the plain language of the statute, relying on Cove standard is the standard that would apply to disparate the broad purpose of the FHA. Arlington Heights II, 558 F.2d at impact claims under the FHA and ECOA if such claims can 1288–89. The Rizzo court similarly concluded that the FHA be brought at all. permitted disparate impact claims by looking to the broad purpose of the statute rather than the plain language of the 12. Implementation of the Fair Housing Act’s Discriminatory statute. Rizzo, 564 F.2d at 126. Rizzo also relied on Black Jack Effects Standard, 78 Fed. Reg. 11,460 (Feb. 15, 2013) (codified and Arlington Heights II. Rizzo, 564 F.2d at 147, 148 n.31. As at 24 C.F.R. 100). discussed above, City of Jackson clarifies that disparate impact 13. CFPB Bulletin 2012-04 (Fair Lending) (Apr. 18, 2012), available must be permitted by the language of the statute, not merely at http://files.consumerfinance.gov/f/201404_cfpb_bulletin_lending_ the broad purpose of the statute, and that therefore under- discrimination.pdf. The CFPB incorporated the FRB’s Official mines the holding of Arlington Heights II. For a more detailed Staff Commentary into its commentary to Regulation B. 12 description of lower court cases that initially held that the C.F.R. Pt. 1002, Supp. I, Comment 6(a)-2. FHA permits disparate impact claims, see Jensen, Kirk D. and 14. See, e.g., Perez, Thomas E., Speech to 15th Annual Community Naiman, Jeffrey P., “The Fair Housing Act, Disparate Impact Reinvestment Act and Fair Lending Colloquium (Nov. 7, 2011), Claims, and Magner v. Gallagher: An Opportunity to Return to available at http://www.justice.gov/crt/opa/pr/speeches/2011/crt- the Primacy of the Statutory Text,” 129 Banking L. J. 99 (Feb. speech-111107.html (“The Civil Rights Division will make use 2012). of all the tools in our arsenal to root out discrimination, includ- ing disparate impact theory if the facts support its application.”).

9 • Banking & Financial Services Policy Report Volume 33 • Number 2 • February 2014 15. Smith v. City of Jackson, 544 US 228 (2005). 39. See, e.g., Alexander v. Sandoval, 532 US 275, 288 (2001); see also 16. 544 US 228 (2005). National Community Reinvestment Coalition, 573 F. Supp. 2d at 77-79 (“We have never accorded dispositive weight to context 17. Title VII § 703(a), 42 U.S.C. § 2000e-2(a) (emphasis added). shorn of text … in interpreting statutes generally … legal context 18. City of Jackson, 544 US at 234. matters only to the extent it clarifies text.”). 19. Griggs, 401 US at 426 (quoting Section 703(a)(2), but omitting 40. Cubita, Peter, and Hartmann, Michelle, “The ECOA quotation of Section 703(a)(1)). Discrimination Proscription and Disparate Impact—Interpreting 20. City of Jackson, 544 US at 235–36 (emphasis in original). the Meaning of the Words That Actually Are There,” 61 Bus. Lawyer 829, 836 (2006) (discussing cases). 21. City of Jackson, 544 US at 234 (quoting Griggs, 401 U.S. at 432 (emphasis in original)). 41. S. Rep. No. 94-589, at 4–5 (1976); H.R. Rep. No. 94-210, 22. City of Jackson, 544 US at 235–36 (emphasis in original). at 5 (1975); see also PCubita and Hartmann, supra, n.40, at 836–37 (2006) (discussing legislative history of ECOA). The 23. City of Jackson, 544 US at 234. 1976 amendments to ECOA expanded the prohibited bases of 24. City of Jackson, 544 US at 236–38. ECOA to include race, age, and other attributes, but did not add 25. City of Jackson, 544 US at 249 (O’Connor, J., dissenting). “effects” language to ECOA or otherwise change the basic “dis- criminate against … because of” structure of the statute. Cubita 26. Raytheon Co. v. Hernandez, 540 US 44, 53 (2003) (emphasis and Hartmann, supra, n.40, 838 (2006). added). 42. As originally enacted, ECOA contained an antidiscrimination 27. Alexander v. Choate, 469 US 287, 299 (1985). provision using only the “discriminate against … on the basis of” 28. Chisom v. Roemer, 501 US 380, 404 (1991). formulation found in Section 703(a)(1) of Title VII and Section 29. 42 U.S.C. § 1973(a) (emphasis added). 4(a)(1) of the ADEA: “It shall be unlawful for any creditor to discriminate against any applicant on the basis of sex or marital 30. Jackson v. Birmingham Bd. of Educ., 544 US 167, 178 (2005) (Title status with respect to any aspect of a credit transaction.” Pub. L. IX); Alexander v. Sandoval, 532 US 275, 280-81 (2001) (Title VI); No. 93-495, tit. V, § 503, ECOA § 701(a), 88 Stat. 1500, 1521. Castenada v. Pickard, 648 F.2d 989, 1001 (5th Cir. 1981) (Equal An amendment to ECOA in 1976 expanded the prohibited Education Opportunities Act); Robinson v. Paragon Foods, Inc., bases, but did not add any “effects” language to the statute or 2006 WL 2661110, at *6 (N.D. Ga. Sept. 15, 2006) (Title II). otherwise alter the “discriminate against …. on the basis of” 31. See, e.g., Alexander v. Sandoval, 532 US 275, 286–87 (2001) formulation. (“Without [statutory intent], a cause of action does not exist and courts may not create one, no matter how desirable that 43. Jones v. United States, 526 US 227, 238 (1999) (quoting Pension might be as a policy matter, or how compatible with the stat- Benefit Guaranty Corporation v. LTV Corp., 496 US 633, 650 ute.”); Wards Cove, 490 US at 655 n.9; Watson, 487 US at 991. (1990) (internal quotations and citations omitted)). 32. Freeman v. Quicken Loans, Inc. No. 10-1042, 2012 WL 1868063, 44. Koons Buick Pontiac GMC, Inc. v. Nigh, 543 US 50, 73 (Scalia, J., at *12–13 (U.S. May 24, 2012). dissenting). 33. Pub. L. 90-284, April 11, 1968, 82 Stat. 73 (FHA); Pub. L. 45. Prior to City of Jackson, 11 of the 12 federal courts of appeal had 88-352, July 2, 1964, 78 Stat. 241 (Title VII); Pub. L. 90-202, permitted disparate impact claims in the fair lending context, Dec. 15, 1967, 81 Stat. 602 (ADEA); Pub. L. 93-495, Oct. 28, notwithstanding lack of support for disparate impact liability in 1974, 88 Stat. 1510 (ECOA). the text of the statute. See Graoch Assocs #33, L.P. v. Louisville/ Jefferson County Metro Human Relations, Comm’n, 508 F.3d at 34. Acree v. Republic of Iraq, 370 F.3d 41, 61 (D.C. Cir. 2004) (Roberts, 374; Reinhart v. Lincoln County, 482 F.3d 1225, 1229 (10th Cir. J., concurring). 2007); Charleston Housing Auth. v. US Dep’t of Agric., 419 F.3d 35. See, e.g., Asgrow Seed Co. v. Winterboer, 513 US 179, 187 729, 740–41 (8th Cir. 2005); Langlois v. Abington Hous. Auth., (1995). 207 F.3d 43, 49–50 (1st Cir. 2000); Simms v. First Gibraltar Bank, 36. See, e.g., Random House Unabridged Dictionary, “Discriminate” 83 F.3d 1546, 1555 (5th Cir. 1996); Jackson v. Okaloosa County, (2006); Jackson v. Birmingham Bd. of Educ., 544 U.S. 167, 175 Fla., 21 F.3d 1531, 1543 (11th Cir. 1994); Keith v. Volpe, 858 (2005) (“ ‘Discrimination’ is a term that covers a wide range of F.2d 467, 484 (9th Cir. 1988); Huntington Branch, NAACP v. intentional unequal treatment.” (emphasis added)). Town of Huntington, 844 F.2d 926, 938 (2d Cir. 1988), aff’d, 488 U.S. 15 (1988); Resident Advisory Board v. Rizzo, 564 F.2d 126, 37. Relman, John P., Housing Discrimination Practice Manual § 2:24 149–50 (3d Cir. 1977); Betsey v. Turtle Creek Assocs., 736 F.2d 983, (2005) (“A defendant with the best of intentions—indeed, even a 988–89 (4th Cir. 1984); Metropolitan Housing Dev. Corp. v. Village defendant who undertakes a particular policy in the express hope of Arlington Heights (Arlington Heights II ), 558 F.2d 1283, 1290 of eliminating any possible discrimination—can still be held liable (7th Cir. 1977). if a plaintiff pursues a disparate impact claim.” (emphasis added)). 46. Cox v. City of Dallas, Tex., 430 F.3d 734, 746 (5th Cir. 2005); 38. See, e.g., National Community Reinvestment Coalition v. Accredited Gallagher v. Magner, 619 F.3d 823, 833–34 (8th Cir. 2010); Home Lenders, 573 F. Supp. 2d 70, 77-79 (D.D.C. 2008). Charleston Hous. Auth. v. US Dept. of Agric., 419 F.3d 729, 740–741 (8th Cir. 2005) (stating that the FHA permits disparate

Volume 33 • Number 2 • February 2014 Banking & Financial Services Policy Report • 10 impact claims and citing Black Jack ); Darst-Webbe Tenant Ass’n 60. 59 Fed. Reg. 18266, 18268 (Apr. 15, 1994) (“The courts have Bd. v. St. Louis Hous. Auth., 417 F.3d 898, 902 (8th Cir. 2005); recognized three methods of proof of lending discrimination Affordable Hous. Dev. Corp. v. City of Fresno, 433 F.3d 1182, 1194 under the ECOA and the FH Act: …”); 59 Fed. Reg. at 18269 (9th Cir. 2006); Reinhart v. Lincoln County, 482 F.3d 1225, 1229 (“Although the precise contours of the law on disparate impact as (10th Cir. 2007); Hallmark Developers, Inc. v. Fulton County, 466 it applies to lending discrimination are under development … .”). F.3d 1276, 1286 (11th Cir. 2006); Graoch Assocs. # 33, L.P. v. 61. 12 C.F.R. § 202.6(a) n.2. Louisville/Jefferson County Metro Human Relations Comm’n, 508 62. 12 C.F.R. Pt. 202, Supp. I, Comment 6(a)-2. F.3d 366, 371 (6th Cir. 2007). 63. CFPB Bulletin 2012-04 (Fair Lending) (Apr. 18, 2012), available 47. Garcia v. Johanns, 444 F.3d 625, 633 n.9 (D.C. Cir. 2006). at http://files.consumerfinance.gov/f/201404_cfpb_bulletin_lending_ 48. Gallagher v. Magner, 636 F.3d 380, 383 (8th Cir. 2010) (Colloton, discrimination.pdf. J., dissenting). 64. 12 C.F.R. Pt. 202, Supp. I, Comment 6(a)-2. 49. 444 F.3d 625, 633 n.9 (D.C. Cir. 2006) (citations omitted). 65. Smith v. City of Jackson, 544 US 228, 240 (2005) (“While the 50. Gallagher, 636 F.3d at 383. relevant 1991 amendments expanded the coverage of Title VII, 51. Petition for Writ of Certiorari, 2011 WL 549171, *i (Feb. 14, they did not amend the ADEA or speak to the subject of age 2011); Gallagher v. Magner, No. 10-1032. discrimination.”). 52. Gallagher v. Magner, 636 F.3d 380, 381 (8th Cir. 2010). 66. Guardians Ass’n v. Civil Serv. Comm’n, 463 US 582, 614 (1983) 53. See Steinhauser v. City of St. Paul, 595 F. Supp. 2d 987 (D. Minn. (O’ Connor, J., concurring); see also Guardians Ass’n v. Civil 2008). Serv. Comm’n, 463 US at 613 (“ ‘Reasonably related to’ simply cannot mean ‘inconsistent with.’ ”); American Federation of Gov’t 54. Gallagher v. Magner, 619 F.3d 823, 838 (8th Cir. 2010). Employees, AFL-CIO v. Gates, 486 F.3d 1316, 1321–22 (D.C. 55. Press release, “City of St. Paul Seeks to Dismiss United States Cir. 2007) (“If the relevant statutory language is plain but is Supreme Court Case Magner vs. Gallagher” (Feb. 10, 2012), avail- inconsistent with the [agency’s] regulations, we must hold the able at http://www.stpaul.gov/index.aspx?NID=4874&ART= regulations invalid.”). 9308&ADMIN=1. 67. Alexander v. Sandoval, 532 US 275, 286 n.6 (2001) (quoting with 56. See, e.g., Biskupic, Joan, “Analysis: Rights Groups Try to Avoid approval Guardians, 463 US at 613 (O’Connor, J., concurring) U.S. High Court Setback,” Reuters.com (Mar. 2, 2012), available at (emphasis in original)). http://www.reuters.com/assets/print?aid=USTRE82117X20120302 68. Freeman v. Quicken Loans, Inc. No. 10-1042, 2012 WL 1868063, (discussing efforts by civil rights advocates and government at *12–13 (US May 24, 2012). ­officials to persuade the City of St. Paul to withdraw its appeal out of concern that the Supreme Court would rule in favor of 69. Id., at *5. the City). 70. E.g., Presley v. Etowah Cnty. Comm’n, 502 US 491, 509–10 57. See, e.g., Stohr, Greg, “N.J. Housing-Bias Accord Scuttles U.S. (1992). Supreme Court Case,” Bloomberg (Nov. 13, 2013). 71. Freeman, supra, n.68 at *5. 58. American Insurance Ass’n v. U.S. Dep’t of Housing and Urban 72. Alexander, supra, n.67 at 286 n.6 (2001) (quoting with approval Development, No. 1:13-cv-00966-RJL, Compl. filed in D.D.C. Guardians Ass’n v. Civil Serv. Comm’n, 463 US 582, 613 (1983) June 26, 2013. (emphasis in original)). 59. 76 Fed. Reg. at 70923. 73. Watson v. Fort Worth Bank & Trust, 487 US 977, 993 (1988). 74. Id., at 993.

11 • Banking & Financial ServicesPosted Policy from Report Banking & Financial Services, February 2014, with permission from AspenVolume Publishers, 33 • Number 2 • February 2014 a WoltersKluwer Company, New York, NY1-800-638-8437, www.aspenpublishers.com. For more information on the use of this content, contact Wright’s Media at 877-652-5295. 109310